Is there objection? Hearing none, the record will receive them. (The prepared statement follows:) (For exhibits, see appendix M through R on pp. 1833-1895.) STATEMENT OF HERMAN W. BEVIS, EXECUTIVE DIRECTOR AND MEMBER OF BANKING AND SECURITIES INDUSTRY COMMITTEE Mr. Chairman, gentlemen, you have requested comments on a number of matters under three general headings. Most of my comments will be addressed to the first two of your sets of questions, namely, "Development of Depositories" and "Development of a Machine-Readable Certificate and Accompanying Documents." Some of the subjects in your third category of questions would appear to involve only the securities industry and, as such, outside the scope of BASIC, which confines itself to matters involving both the banking and securities industries. I am attaching to this statement as Exhibit A brief answers to your specific questions, supplementing other answers given in this statement. 1. DEVELOPMENT OF DEPOSITORIES The immobilization of certificates in a national comprehensive securities depository system (CSDS) has emerged as by far the most important objective of BASIC and its Task Force. Transfer of ownership of the greatest practicable number of immobilized certificates by book-entry-with no physical certificate movement-has been given top priority. We have given attention first to a New York CSDS, since that is where the problem exists in overwhelming magnitude, but at all times we have had an eye toward making this depository compatible with a nationwide system. The immobilization concept BASIC believes that it is entirely feasible, within the relatively near term, to have a nationwide network among financial institutions whereunder a significant percentage of certificates will be immobilized, and transfers of ownership of the immobilized certificates will be accomplished by book-entries. There are those who are vocal in advocating compulsory elimination of the stock certificate. Some of them often sound as if they are proposing that this be done immediately, i.e., before a system for establishing the ownership of securities and of effecting changes therein has been developed and proved beyond doubt. We think that it would be very dangerous to pursue such a course. We do not by any means rule out the ultimate possibility-even desirability— of compulsory elimination of the stock certificate. In fact, if that is to be an end, we believe that we are taking the quickest of all feasible courses toward it-through CSDS-through establishing a system which will prove to everyone's satisfaction that security ownership and changes therein can be accurately and reliably accounted for without using the certificate as evidence. The Central Certificate Service of the New York Stock Exchange ("CCS") Perhaps the persuasive reason why we are so confident as to dramatic, nearterm benefits from a CSDS-is the Central Certificate Service of the New York Stock Exchange. CCS is a very large depository. It is in successful operation. Right now, it holds certificates for about 1 billion shares. The users of CCS express widespread satisfaction with its services. The number of shares on deposit in CCS, and the number of transactions recorded, have been growing very fast. AMEX and O-T-C stocks have recently been added to the eligible issues, and registered corporate bonds are being incorporated. BASIC has encouraged increasing the list of users of CCS even before it is expanded into the more comprehensive depository. This is taking place. New York Clearing House banks have been participating in a book-entry broker collateral loan program via CCS for some time now, at the same time acting as sub-custodian for portions of CCS securities. These banks have also been delivering securities to, and receiving them from, brokers via CCS. CCS recently announced the conclusion of arrangements with banks in several other states to participate in its book-entry broker collateral loan program. It is discussing with out-of-state banks, and clearing corporations of the Midwest and Pacific Coast Stock Exchanges, their becoming depositors in CCS and delivering and receiving securities by book-entry for New York transactions. CCS is also discussing with several dealers-not NYSE members-the possibility of their becoming depositors. Thus, CCS is already becoming an interstate facility for the effecting of securities transactions by book-entry, and is extending its depositor list beyond exchange member firms. All this directly furthers BASIC's objective of a comprehensive depository. A New York Comprehensive Securities Depository System ("NYCSDS”) BASIC is developing a NYCSDS by building upon-expanding CCS. Last month, the last signature was affixed to a "Memorandum of Understanding" by the New York and American Exchanges, NASD, and the eleven New York Clearing House banks. This event was then announced to the public both to give tangible evidence of progress in solving the problems of handling securities transactions and to present a down-to-earth means by which this can be done. Some of the more important principles expressed in this Memorandum are: 1. NYSE would place the operations of CCS in a separate subsidiary ("CCS, Inc.") and be prepared to spin it off when the Uniform Commercial Code is amended to permit ownership of it by participants other than an exchange. Stock Clearing Corporation, of which CCS is now a part, would continue to compare, clear and settle trades and provide the other facilities and services (other than CCS) as at present. 2. Meanwhile, as an interim measure, NYSE as sole stockholder would agree to vote for directors in designated numbers nominated by AMEX, NASD and the banks. 3. All Parties agree to work for amendments to state laws to end that fiduciary securities held by banks may be deposited in a CSDS. 4. The plan calls for incorporating CCS Inc. as a trust company under New York law, making it subject to regulation by the New York State Banking Department. 5. Eligible depositors would be confined to financial organizations under regulation or supervision of a federal or state authority. This would include broker-dealers, banks, mutual funds, insurance companies, and clearing corporations of NASD and exchanges if such direct depositor status fits best their clearing systems. 6. Immobilization of certificates to the greatest extent practicable being the objective, the pressures would be to make eligible as many issues as practicable, to make eligible as many depositors as practicable, and to immobilize certificates of smaller financial organizations in a CSDS via correspondents. 7. Interconnection with a national CSDS "in order that securities ownership and transactions throughout the United States can be recorded by book entry" is a planned and announced objective. 8. The owners of the depository would be its users. It is to be non-profit, i.e., fees from users should approximately equal costs. Agreement on the principles and objectives incorporated in the Memorandum of Understanding is a significant step in a voluntary, collaborative endeavor. At the same time, none of the Parties is under any illusions as to the obstacles on the rocky road to binding agreement as to, and the effective operation of, CSDS. An implementing group of approximately ten people working full time to research and work out details has been detached from organizations representing the Parties, with participation by the Task Force of BASIC. We believe that we are not optimistic in predicting that a NYCSDS will be in effective operation not later than the first half of calendar 1972. The New York banks, the two Exchanges and NASD have already spent outof-pocket more than $500,000 in support of BASIC's effort, and this figure may well be more than doubled before the job is done. This does not include any amount for time spent by the participating organizations' own staff in helping BASIC's Task Force with research and planning. The cost of this time would be substantial. A national comprehensive securities depository system For about a year, the BASIC Task Force has held monthly meetings with representatives from the Boston, California and Chicago financial communities. From Philadelphia, the head of the P-B-W exchange clearing corporation re cently joined these discussions. The purpose of those meetings has been to inform the out-of-state representatives of BASIC's thinking and planning and receive their suggestions-all to the end that other parts of the country could move as fast as possible in helping build regional CSDSs which would tie in with the one developed in New York and vice versa. Research to date indicates that perhaps some three-quarters of all certificate handling among broker/dealers and banks in the United States presently takes place in New York City. Of the remainder, about half seems to be concentrated in five states: California, Massachusetts, Illinois, Pennsylvania and New Jersey. Of these five, three are geographically rather close to New York City. Out of our monthly meetings has evolved a working hypothesis that depositories housing physical certificates may not need to number more than three: California, Chicago, and New York. The principal reason why this could be so is that, under a comprehensive depository system, the physical location of immobilized certificates becomes of minimal importance. It is the system for maintaining records of securities ownership and changes therein by book-entry that becomes paramount. Centralized ownership recordkeeping services in California, Chicago, and New York may also meet the nation's need for a book-entry system to effect securities transactions among financial organizations. All banks, brokers, and other financial organizations in the country would need to tie in with one or more of these three depositories. They would do this as direct depositors if their volume of securities holdings and transactions so warranted, or via correspondents if it did not. Their communication link with the depository could be by mail, teletype or, ultimately, computer link depending, again, on the volume of transactions, but also on the time frame within which transactions must be completed. Studies of securities depository systems in Europe particularly Germany and France where they have been in successful operation for decades-prove the feasibility of a national system for the United States, even after allowing for our much higher volumes and other differences. Estimated effect of CSDS on the volume of certificate movements Statistics which would show the probable effect of a CSDS on certificate movements have not heretofore existed, and are hard to develop. The BASIC Task Force has spent much time in this area, because extensive certificate movements were a heavy contributor to the securities industry's operating problems in 1968-69. One needs to know how much this solution will help. A very high percentage of physical securities deliveries of the type that brokers were making in 1968 have already been eliminated-and delivery by book-entry substituted-through the operations of CCS. Our latest research study attempts to measure the remaining movements that would be eliminated by a CSDS. A copy of this research report is attached to this statement as Exhibit B. A key statistic is how much of the existing movements by broker/dealers and banks would be eliminated, for it is these people who have had the so-called "back office" problems. Our study indicates that if all broker/dealers and banks in the country were tied together in a CSDS, their physical certificate movements of issues eligible for deposits would be reduced about 75%. A NYCSDS alone would reduce the movements of broker/dealers and banks in that city by about half. As to the effect on transfer agents' volume, the study estimates that, with a depository operating in New York alone, the number of new certificates issued would be reduced by some 40%. A national CSDS would reduce the new certificates by some two-thirds. In estimating the impact of a CSDS, we have assumed no change in the existing pattern of certificate holdings in individuals' names. In our recent study, 18% of the certificates examined were so registered and these accounted for 22% of all recorded actual movements. As certificates held by members of the financial community are further immobilized in a CSDS, naturally certificates in individuals' names will account for a higher proportion of the then reduced number of certificate movements handled by broker/dealers and banks-probably ranging up to 50% or more. In this future environment, it seems more than probable that attention will be concentrated on attracting certificates in the names of individuals into a CSDS. At that point, we would be approaching the certificateless society. 2. DEVELOPMENT OF A MACHINE-READABLE CERTIFICATE AND ACCOMPANYING DOCUMENTS The question of making the certificate and accompanying documents machinereadable, by the Optical Character Recognition ("OCR") technique as well as punched holes, had been under extensive discussion for at least two years before BASIC was formed in early 1970. This being so, it was natural that BASIC's Task Force would include this subject in its earliest studies. Two variations of a machine-readable engraved certificate of approximately the current size, as well as an engraved card certificate with punched holes, were investigated. We researched the current availability, cost and performance of OCR equipment to machine-read certificates; the relative security of card and page sized certificates against counterfeiting, loss and theft; the cost/benefit ratios and procedural considerations after conversion by banks and brokers to a system based upon machine-readable documents; the operational problems of conversion; and the cost and time of banknote companies to convert. The product of this research was included in a widely circulated "Discussion Paper" dated September 9, 1970, a copy of which is attached as Exhibit C. Among the reactions received to this Discussion Paper were strong questions as to whether or not OCR equipment-particularly low-cost reading equipmentwas as ready for an extensive machine-readable cretificate system as the Discussion Paper indicated. The Task Force followed this matter up. Members of the Task Force visited almost every maker of OCR reading equipment who to our knowledge had asserted that they were ready for the problem. All equipment was tested with actual engraved certificates imprinted with OCR characters. We found that most of the equipment (all of that of low cost) could not satisfactorily handle the problem: there were far too many misreads and can't reads of the characters. Even the most expensive equipment required extremely careful quality control in the process of imprinting OCR characters, or they too had difficulty with the reading. A copy of the research report dated February 2, 1971, covering this phase of our work is also attached as Exhibit D. Meanwhile, others of the Task Force were vigorously pursuing the matter of creating a comprehensive securities depository and evaluating the potential effect of such a system in immobilizing certificates. It began to be clear to me that the removal of most certificates from the vaults and boxes of banks and brokers to a depository might well be accomplished not too long after a machine-readable certificate system could be brought into effective operation. The prospect was that the very extensive costs in time and money to convert the nationwide banking and brokerage industries to a machine-readable certificate system, including all the confusion that would be attendant upon the conversion, probably could not be recouped through the benefits of the system before the certificates became immobilized in a depository. Accordingly, I recommended to the Banking and Securities Industry Committee that the machine-readable certificate project be set aside, and efforts to bring the depository into effective operation be redoubled. The Committee suggested that we not dismiss machine-readable certificates and documents completely, but rather, keep an eye out for any technological developments which might promise more timely and less costly systems. We have done this, but no convincing innovation has come to our attention. Since I reached this conclusion on the machine-readable certificate, time, thought, and effort have brought the prospect of a CSDS even closer to realization than I believed possible earlier. The greatest benefits of machine-readable certificates would have been derived by procedures applied to large accumulations of certificates in bulk without any attachments, mostly in brokers' hands but to some extent in banks. It is precisely these certificates that ought to go into a CSDS. One should not be under any illusions that a CSDS will completely eliminate all certificate handling by brokers and banks. For one thing, a certain quantity of nonfungible securities will probably always be around. These cannot be handled by a depository, so will remain in the hands of banks, brokers and others. However, these are not a large proportion of the total certificates now being handled. There will also continue to be certificates flowing to and from individuals and others outside the "system." As to these items passing through a broker or bank's hands in small quantities with papers attached-a machine-readable certificate never promised extensive cost and time savings. Moreover, an effec tive CSDS which gains the confidence of the investing public will probably attract more and more of these certificates into the system, thus also eliminating their movement. If the only hope of helping the financial community's certificate handling problem was the machine-readable certificate, I would be among the foremost advocating it, notwithstanding all of the problems yet to be solved and the costs that would have to be incurred. However, this is largely a choice among alternatives with the time factor a very important consideration. I believe that immobilization of certificates in a CSDS will take over the problems as quickly, if not more quickly, more effectively, and with more lasting benefits than an extensive industry-wide system centered on the machine-readable certificate. A memorandum that I presented to BASIC along these lines is attached as Exhibit E. Mr. Chairman, I should be more than glad to answer any questions. Thank you. Mr. Moss. Mr. Richard Howland, president, Stock Clearing Corporation, New York Stock Exchange. STATEMENT OF RICHARD B. HOWLAND, PRESIDENT, STOCK CLEARING CORPORATION, NEW YORK STOCK EXCHANGE, INC. Mr. HOWLAND. Thank you, Mr. Chairman. My name is Richard B. Howland. I am executive vice president of the New York Stock Exchange and president of the Stock Clearing Corporation. I am pleased to respond to the chairman's invitation to appear as a panelist on behalf of the New York Stock Exchange, Inc. I want to take the opportunity to express the exchange's desire to cooperate fully with the subcommittee. Chairman Moss' letter of September 23, inviting the exchange's participation at these hearings, outlined three major topics to be considered at the hearings. I have already submitted a 44-page statementwith exhibits-which gives the exchange's views in detail on the three subjects. For purposes of today's hearings, I will briefly summarize those views. 1. DEVELOPMENT OF DEPOSITORIES The concept of a central securities depository is not, in itself, new. They have existed in Europe since the previous century, and have been under study by the exchange since 1938. In 1957, when daily volume averaged 2.2 million shares per day, the exchange embarked upon a long experimental effort on a method for "centralized handling of securities." In April 1962, the exchanges board of governors authorized the staff to proceed toward implementation. Clearing members actually began depositing in their CCS accounts in June 1966. Initially, CCS involved only New York Stock Exchange member brokerage firms and New York Stock Exchange listed stocks. During 1970, banks began effecting deliveries and receipts through their CCS accounts. In late 1970 and early 1971, some 960 American Stock Exchange issues were phased into the system, followed in mid-1971 by some 150 over-the-counter issues. At present, over 1 billion shares of more than 2,500 stocks are on deposit in CCS-about double the number of shares in CCS at the start of 1971. The basic legislative change needed for the development and use of the central depository concept permitted transfer of title to shares 67-228 O 72 pt. 3 2 |